Overview of microfinancing
ADB defines microfinance as provision of a broad range of financial services such as deposits, loans, payment services, money transfers, insurance to poor and low-income households and their microenterprises. There are three types of sources of microfinance: formal institutions - i.e. rural banks and cooperatives, semiformal institutions - i.e. nongovernment organizations, and informal sources - i.e. money lenders and shopkeepers. Institutional microfinance includes microfinance services provided by both formal and semiformal institutions. Microfinance institutions are institutions whose major business is the provision of microfinance services.
About 90% of the 180 million poor households in the region still lack access to institutional financial services. Most formal financial institutions deny the poor financial services because of perceived high risks, high costs involved in small transactions, the poor's inability to provide marketable collateral for loans.
Microfinance provides financial services, primarily savings and credit, to poor and low-income households that normally do not have access to formal financial institutions. It is widely documented that the formal financial system rarely provides access to poor entrepreneurs in developing economies. It is estimated that in most developing countries, the formal financial system reaches at a maximum the top 25 per cent of the economically active population, leaving the bottom 75 per cent without access to financial services apart from moneylenders. This is because the techniques used by financial institutions do not enable them to lend to the poor in a cost-effective manner.
One critical constraint which may prevent regulated banks from lending directly to the poor relates to interest rates. Microfinance is an inherently costly activity. Effective microfinance programs require intensive inputs in motivating and training borrowers and in follow-up, with regular monitoring and frequent loan repayments. Programs must go to where the borrowers are, rather than being located in regional centres. All of these factors add to costs. And loan amounts are small, implying low interest income per loan. To be sustainable, microfinance programs must therefore charge higher rates of interest than those charged on other loans. This is true regardless of whether programs are undertaken by specialised MFIs or regulated banks. The Grameen Bank, the largest and one of the most efficient microfinance programs in the world, charges an effective interest rate of 20 per cent per annum, and most smaller programs need to charge considerably more than this to be sustainable. Even if regulated banks adopt the techniques of specialist MFIs, they need to charge higher interest rates on their microfinance loans than on their other loans if their microfinance programs are to be sustainable.
Today, it is generally accepted that populations traditionally excluded from the formal financial sector can, in fact, be a profitable market niche for innovative banking services, and that microfinance can be very important in reducing poverty. The success of microfinancing activities in many countries including the Philippines show that it is possible to serve loans to finance the economic enterprises of the very poor (1) as a commercial activity that pays for itself, (2) without subsidy from government, and (3) with a very high repayment rates or very low defaults on loans, even in the absence of collateral. These are based on the observations that the poor need sustained access to financial services more than lower interest rates and they have the capacity to repay their loans and to save. Given these, microfinancing can be operationally and financially self-sufficient.
Although the microfinancing industry has gained fame only over the past three decades following the success of the Grameen Bank (“Bank of the Villages”) in Bangladesh, cooperatives have actually been in the business of providing financial services to the poor over more than 100 years, beginning with the “village bank movement” (or credit unions) initiated by Friedrich Wilhelm Raiffeisen, who was mayor of several German municipalities over the course of his career.
A distinction can be made between cooperatives and “microfinancing institutions.” Cooperatives are owned and governed by their members who are the savers and borrowers themselves and often build their capital from members. Other microfinancing institutions are organized as non-profit corporations or foundations governed by trustees in behalf of patrons that contributed the funds. Because of their nature as user-owned services, credit co-ops are sometimes thought of as conveniently catering more to the needs of the capable non-poor who can pay for their equity share and for the loans that they take out. Microfinance NGOs came to be seen as the only institutions with a directed focus on the poor and the technology for reaching the poor, but only that they are dependent on external resources of funds as non-profit and non-stock organizations.
Some private commercial banks are beginning to target the microfinancing market and would have the most extensive mechanism to undertake financial delivery. But private banks are still seen generally as lacking the willingness, the technology, and the vision to lend to the poor. Government supply-led credit programs would have the advantage of funding from government budgetary allocations and donor agencies, but that they are inefficient and unsustainable.
Co-ops could not have simply accommodated the poor outside their membership. Even as organizations focused on the poor and just like the microfinance NGOs, co-ops face the same information problems, inadequate collateral, and high transaction costs associated with processing small loans to those outside their membership. In the 1980s, attempts to dramatically increase membership in co-ops created tremendous past due accounts as high as 60%. The bankruptcy of some co-ops that followed created a conservative and cautious attitude to rapid expansion of membership. Even today, co-ops normally seek out ways to address the credit needs of the poor beyond their existing membership but not at the risk of high delinquency. However, the same cautiousness has produced a valuable experience among co-ops that high delinquency has nothing to do with the clientele. Whether a person is poor or not, delinquency issues can be resolved by imparting the needed knowledge and skills to the board and management running a financial service co-op.
As they claim to be the original microfinancing institutions, co-ops lately have started to present programs directed at non-members using the more recent microfinancing innovations. It differs from other microfinance programs in that co-op microfinance involves a process of raising the poor to the level of regular members with shareholdings and voting rights.
Government role in micro-financing
In the Philippines, there used to be at least 111 government credit programs, many of which involved government agencies lending directly to final borrowers. These programs have been criticized for being inefficient, highly politicized, uncoordinated and unsustainable. “Philippine experience has shown the huge inefficiency and high costs of using government non-financial institutions to implement credit programs. Recent research has shown the un-sustainability of government supply-led credit programs, the great capacity for leakage of the benefits of government credit programs to the non-poor, the duplication and overlapping of a number of credit programs leading to gross inefficiencies, the distortion of the financial market and weakening of private sector incentive to innovate.”
In 1995, the government established the People’s Credit and Finance Corporation (PCFC) as a government finance company for lending to the poor. The National Credit Council envisages that the corporation should gradually replace many of the other lending programs operated by line agencies of government.
PCFC lent funds to NGOs, rural banks, cooperatives and other intermediaries as ‘conduits’ for on-lending to the poor and aimed to ensure that such intermediaries are replicable, self-sustaining and operationally viable. PCFC also availed of funds from ADB and the International Fund for Agricultural Development exclusively to support microfinancing institutions replicating the Grameen Bank approach. PCFC also lent funds to conduits for capacity building.
Local government role in micro-financing
A local initiative that aims to use microfinancing as a tool for employment generation would then have to consider the emergence of viable microfinancing institutions, the phase out of credit programs directly provided by government agencies and their rationalization through PCFC, and the use of the microfinancing institutions as conduits of PCFC funds.
Although local governments may not access government funding to provide loans to end-users, they can perform other activities to facilitate micro-financing activities. In the survey of Asian countries undertaken by Banking with the Poor (BWTP), local governments seemed to play a role more in terms of identifying the targets of government-led credit programs. But rather than just being a tool in supply-driven credit programs, local governments can play the role of a genuine facilitator between the poor who seek out micro-financing and micro-financing institutions who seek out clients who are poor.
Microfinancing NGOs and co-ops are a response to the inability of private commercial banks to serve the credit needs of the poor. However, micro-financing institutions including cooperatives would, like private banks, also face costly information gathering needed to enable them to begin extending their services to new areas. At their end, the poor face the problem of searching for the financing package at the least cost and most suited to their needs.
Given a policy goal of helping the poor in accessing financing, local governments can use its machinery to identify and attract the poor for the benefit of microfinancing institutions, and to identify and attract the microfinancing institutions for the benefit of the poor. If these information services are operated on a regular basis, as what the Quezon City government is doing, the cost faced by the two parties can be drastically reduced and market transactions facilitated. More micro-financing supply would be forthcoming if the local government proved to be effective in identifying the clients sought by the microfinancing institutions. Information problems can be mitigated by local governments without incurring the same moral hazard problems present when they are used merely to identify the recipients of a government lending at a pre-set supply amount (example: Lingap para sa Mahihirap).
Quezon City experience
Quezon City provides a concrete example of local government facilitation of the micro-financing market.
In 2001, Quezon City started the Task Force Sikap Buhay to implement an assistance program for the city’s small entrepreneurs. In 2005, the program was transformed into the Sikap Buhay Entrepreneurship and Cooperatives Development Center (SBCC). There is a pending move to transform SBCC into a regular city department. SBCC is the equivalent of the cooperative development office (CDO). The appointment of provincial, municipal, and city cooperative development officers are authorized under the Local Government Code.
SBCC aims to promote entrepreneurship and self-reliance among its clientele, to expand the number of entrepreneurs and expand their businesses, develop community and institution-based training for entrepreneurial skills and values, and coordinate city-based co-ops, concerned government agencies, and local bodies.
Its three major programs are the following:
1. Facilitating access to capital loans and continually finding ways to increase the sources of capital loans. SBCC has assisted more than 20,000 micro-entrepreneurs in the last five years to access capital loans from its conduit or partner microfinancing organizations, which are cooperatives.
2. Expanding entrepreneurship training services by organizing entrepreneurship skills and leadership seminars through in-house trainors and institutional partners
3. Promoting cooperativism by proactively advocating the concept of cooperatives for economic endeavors, closely networking and coordinating with cooperative federations and alliances, promoting small entrepreneurs’ co-ops, and coordinating with the implementing the objectives of the Cooperative Development Authority. SBCC has published a Cooperatives Directory of Quezon City.
Quezon City is undertaking a micro-financing facilitation program that matches poor entrepreneurs with microfinancing institutions. Under this program, the city government entered into memo of agreements with Cooperative Rural Bank of Bulacan (CRBB), Novaliches Development Cooperative (NOVADECI), Eurocredit Cooperative to provide loans to the poor identified by the city for microfinancing assistance. These institutions have different pre-existing financing packages and policies and offer different lending rates. The agreements do not impose an obligation on the part of the partner institutions to revise their programs and policies.
CRBB is based in Bulacan but has pre-existing operations in District 2 in northern part of the city. NOVADECI was originally confined to the Novaliches District until it expanded to other parts of the city. Eurocredit is also based in Quezon City.
As a cooperative bank, CRBB has cooperatives as members/owners and can offer financial services to members and non-members, institutions or individuals. It operates a microfinancing program patterned after the world-renowned Grameen model, under which the borrowers, who are individuals, are organized into groups composed of five members who monitor each others compliance with the lending terms.
As primary cooperatives of the savings-and-credit type, NOVADECI and EuroCredit are owned by individuals and offer services only to members. The Grameen-style microfinancing for group borrowers that the two co-ops also offer is therefore contingent on a program of initially enlisting the microfinancing clients as associate members without voting rights and eventually graduating them to full membership. However, prospective borrowers may also opt to at once apply for membership, meet the regular membership requirements, and file the normal procedures for member’s loan applications.
Prospective borrowers among the poor are sought by barangay political leaders and mobilized to hear the orientation seminars, usually for groups of 25 participants, on the different microfinancing programs. The beneficiaries must be poor or with income below the poverty threshold, female, 18 to 60 years old, and must have an existing business, which can be of any type ranging from vending gulaman (sugared drink) to sari-sari store. Most of the beneficiaries in fact are engaged in direct selling business. In addition to these criteria, beneficiaries must be living in the barangay for not less than one year. Residents living in rented houses are secondary priorities. Only 15 out of 25 attendees in the orientation seminars usually qualify under these criteria.
The programs and policies of the microfinancing partners are presented by SBCC staff in orientation seminars. The staff presents first the programs of the microfinancing partner that operates in the areas where the seminar participants came from. As questions from the participants begin to unravel their particular preferences and qualifications, the staff ends up presenting the programs of all the other microfinancing partners. Thus, the needs, preferences and qualifications of the prospective borrowers are matched by information on the microfinancing institution with a program that suits them best.
The choice of microfinancing package by prospective participants is influenced by interest rates and other exigencies. The interest rate in CRBB’s microfinancing program is only 1.5% per month for 6 months and 2.5% in NOVADECI. These are way below what is normally made available to the poor by informal lenders as the most available alternative. Minimum loan is P5,000 per cycle of 6 months. Some participants, undergoing successive cycles, have already qualified to take out up to P40,000 in loans.
However, participants in group borrowing must undergo intensive seminars on group values and solidarity, and must actually search for group mates that they can trust. To form a group of borrowers, beneficiaries choose their own group mates who live close together in the same community. Applicants who are otherwise qualified but could not find qualified group mates living near them may not be accommodated by the program.
At least 3 groups composed of 5 borrowers each comprise a center, or at least 15 borrowers per center. Clustering the borrowers’ groups into centers is meant to facilitate monitoring, advisory, and enforcement by SBCC and the microfinancing partner concerned.
On the other hand, individual borrowing does not involve transactional relationship with another borrower or group of borrowers. However, this requires that one becomes a member of the cooperative and hence must put up a share capital and undergo cooperative membership education. This option is available under NOVADECI, which requires a minimum paid up capital of P830, and EuroCredit Co-op, which requires P5,000.
Of the qualified participants that underwent SBCC orientations, 60% opted to become clients of CRBB’s program, 20% of NOVADECI, and 10% of EuroCredit. The remaining 10% opted not to take a financing program. Most participants were generated in 2006, totaling 12,000 to 15,000. Since 2002 when the program started, the total is 20,000 participating poor.
SBCC workers observed that the criteria disqualify the entrepreneurial poor who are otherwise qualified except that they are male and above 60 years old (senior citizens). Persons with disabilities (PWD) and the out-of-school youth (OSY) are not covered by the program. Thus, a 73-year old fruit vendor at Philcoa who approached the program could not be accommodated.
Beneficiaries between 18 to 35 years old comprise 30% of the participants. SBCC staff said 18-year old applicants are accommodated only if she is the breadwinner of the family. Thus, young adults enrolled in the program are either working mothers or siblings supporting their families. However, an 18-year old can be accommodated into a group if one of the five group mates resigns or is disqualified.
The program apparently does not particularly target young people (18 to 25 years old) who may or may not be breadwinners or heads of families. However, the program does promote itself to young people. And yet, young people do tend to select themselves out of the program. SBCC participates as booth exhibitor in the job fair organized by the city government. In one of the job fairs it put up a streamer that read: “Pagod ka na bang maghanap ng trabaho? Bakit di ka magnegosyo?” (Tired of job hunting? Why not start your own business?) Very few young people took interest in the SBCC booth while booths put up by companies were queued by long lines of jobseekers.
SBCC staff further observed that the partners must attempt to accommodate all types of needs. SBCC Microfinance Development Officer Junnie P. Natad observes that CRBB project officers tend to be conservative and inflexible in the application of the qualification criteria. They also tend to rotate frequently post between their main operation in Bulacan and Quezon City, which seemed to him to be just as a training ground for new project officers of the co-op bank. The solution is to expand the set of microfinancing partners, and Natad said SBCC in fact is continuously seeking out more partners so that more beneficiaries and those with different characteristics can be accommodated. These include the senior citizens, PWDs, and OSYs. SBCC Entrepreneurship Division Chief Gloria Alcoran observes that microfinancing programs of the partners do not seem to include the “very, very poor.”
SBCC has 28 staff. There are two line divisions (Entrepreneurship Division and Cooperatives Division) and two staff units (Special Projects and Administration). The Entrepreneurship Division is divided into the Promotion and Networking Unit and the Monitoring Unit. The former is responsible for recruiting and orienting prospective microfinancing beneficiaries and linking with possible microfinancing partners. The latter, which is responsible for monitoring the centers composed of group beneficiaries, is further divided into District 2 Section and the District 1, 3 and 4 Section. There is a pending move to transform SBCC into a regular department of the city government.
Quezon City’s facilitation of microfinancing has benefited a total of 20,000 poor from 2002-2005. Of the total, 15,000 were generated last year alone. If these numbers could have been generated even without the city’s intervention, then the program represents a deadweight loss to the city.
There are indications that the program represents an added value to society. Microfinancing, as an activity that delivers financial services to those who would otherwise be left un-served by financial institutions, is a relatively young industry. Even the cooperatives that traditionally included the poor in its membership are just beginning to target the poorer in their service coverage. The newly organized networks or federations of microfinancing co-ops and NGOs have yet to fully standardize their operations and pool enough resources to provide for common services to make the activities of their members more efficient. Such services may include common promotional activities and common credit investigation bureaus. Local governments can fill these gaps under a program of providing immediate relief to the financing needs of their constituencies.
Cultivating the micro-financing market serves the public interest. Economic information and imparting the values of entrepreneurship, savings, and credit-worthiness as contained in SBCC orientations and field work can be seen as public goods that, just like school education, are at least in principle available also to all types of financial institutions.
From a different take off point, such activities also represent an improvement in the content of the political constituency work of politicians and political parties. In terms of local administration, attracting and mobilizing private microfinancing institutions to meet local goals tend to keep local governments in the business of leading and coordinating, rather than in actually staking out meager public resources when alternatives can be made available.
Replicating the SBCC
Replicating the SBCC initiative should not be particularly difficult, particularly where there are existing microfinancing operations by co-ops or NGOs or both, and where there is an existing city or municipal cooperative development office. The appointment of cooperative officers by local governments is provided under the Local Government Code, although this is optional for provinces and cities (Section 487, R.A. No. 7160). In any case, offices taking care of entrepreneurial promotion and cooperative concerns have been instituted in a number of cities and provinces, partly in response to CDA’s advocacy and to Executive Orders No. 96 that calls on local governments to assist co-ops and to complement the work of CDA.
EO No. 96 mandates that “all departments, branches, subdivisions, and instrumentalities of the Government shall promote the formation of cooperatives under their respective programs by providing them with appropriate and suitable incentives” and instructs local governments to assist CDA in the collection of cooperative annual reports, mediation and conciliation of cooperative disputes, monitoring of compliance of cooperatives with the CDA rules and regulations, and implementation of programs for cooperative promotion and development. These are reflected in the statement of objectives and functions of the local cooperative offices.
Bulacan has its Provincial Cooperative and Entrepreneurial Development Office (PCEDO) even before E.O. No. 96. PCEDO’s Kaunlaran sa Pagkakaisa Program (KPP) initiated during the incumbency of Governor Roberto Pagdanganan involved extending assistance, including financing, to cooperatives. It is one of the most considered local government initiatives in cooperative development and is supposed to have inspired E.O. No. 96.
Muntinlupa City adopted the mandate for local governments under EO No. 96 for the functions, duties and responsibilities of its City Cooperative Office. Aside from technical assistance, the city government allocated P2 million (later increased to P5 million by Mayor Jaime Fresnedi) for lending to cooperatives.
Cooperative offices elsewhere would mostly serve to fulfill the mandate to support the promotion of co-ops, and E.O. No. 96 (which was written by CDA as signed by President Ramos in 1993) seeks to make local governments function like deputized agents of the CDA in assisting and regulating cooperatives, with the expectation that the assisted co-ops will meet local objectives in economic development, creating employment, or making credit more available.
In contrast, the SBCC initiative in Quezon City started on a certain objective, to provide financing to the poor, and enrolled cooperatives that could measure up to the task. E.O. No. 96 does not rule out innovations like Quezon City’s SBCC, but it provides little guidance for local governments on how to drive cooperatives to become more competitive and capable of meeting local goals.
Most cooperatives operating savings-and-credit services to members (who are mostly poor) have yet to extend micro-financing services to non-members (the poorer). However, cooperative micro-financing is catching up, with community-based savings and credit co-ops (like NOVADECI) beginning position in the microfinance market. NATCCO is undertaking a micro-financing program to enable its members to deliver financial services to the enterprising poor on a massive scale. Local governments aiming to help their poor would have to tap into the growing capabilities of these co-ops.
Areas for reforms
SBCC’s weakness in spurring youth entrepreneurship through micro-financing suggests that the youth tend to be more biased to institutional employment and to avoiding taking risks. However, workers generally are risk averse and given a choice will opt for opportunities other than self-employment. This has been observed in the Betcherman et al. studies. However, a study showed that although the young have a relatively low probability of being self-employed, they are distinguished from older age groups in that they are particularly likely to say they would like to be self-employed if they had the choice.
The programs of the microfinancing institutions assisted by SBCC do not particularly target young people in the first place. Thus, SBCC’s record should not be seen as an argument against youth entrepreneurial promotion and youth micro-financing. There are sections of the youth for whom micro-financing is a relevant service, only that a different set of criteria should be expected to make youth micro-financing work. The up-starting entrepreneurial young with yet no track record can be helped by small loans. Local initiatives such as the SBCC can still help young entrepreneurs by linking with an entirely different set of financing partners.
Moreover, a similar link up between local governments and microfinancing co-ops can be devised in the case of employment facilitation and manpower services. Manpower service cooperatives can be tapped to absorb jobseekers referred by the local governments based on the criteria established or required by the agencies.
This falls under the mandate of the Public Employment Service Offices or PESO. PESOs are non-fee charging multi-employment service facility established under Republic Act No. 8759 (or the PESO Act of 1999) in capital towns of provinces, key cities and other strategic areas. Under the Act, a PESO shall ensure the prompt, timely and efficient delivery of employment service and provision of information on DOLE programs (Section 4) along the policy of promoting full employment and equality of employment opportunities for all (Section 2).
Among the functions of a PESO is to encourage employers to submit on a regular basis a list of job vacancies in their respective establishments in order to facilitate the exchange of labor market information between job seekers and employers by providing employment information services to job seekers, both for local and overseas employment, and recruitment assistance to employers (Section 5).
PESO’s job, and that of cooperative offices of local governments, can be facilitated or complemented by manpower service cooperatives, which are workers’ co-ops that operate like investor-owned manpower service agencies that supply on contract workers demanded by firms, except that the supplying firm itself is owned by the workers themselves. As owners, the workers subscribe to the needed capital stock, appropriate the income in the form of worker’s patronage refunds and interest on share capital, and elect the board and management. All things being equal, it is superior to investor-owned agencies that tend to exploit workers.
To remain competitive, manpower service co-ops must respond well to the demand for labor services by firms. This means they must attract into its fold enough number of workers in different skills categories, most of whom do not have the money to pay the subscription needed to become a regular member. However, manpower service co-ops can enroll workers as associate members, without voting rights but undergoing the same program of eventually paying the minimum capital subscription to become members.
Local governments, through the coordination of the PESO and the cooperative office, can provide information on workers in its jurisdiction to the manpower service co-ops and to provide information to workers on the qualification criteria and job requirements sought by the co-ops. This can help manpower service agencies save some costs associated with search and recruitment. It can help PESO and the local government on the costs associated with monitoring the job requirements of several firms and employers. With contractual jobs on the rise and available regular positions declining or not growing enough, monitoring job requirements can be a tedious undertaking.
By providing help to manpower service co-ops in informing and recruiting workers, local governments can encourage the right kind of manpower service co-ops: those that are competitive in supplying labor to firms, can provide the best benefits package to workers, and possibly can provide other services to member-workers such as savings-and-credit, insurance, and pre-needs.
Manpower service co-ops in general would have incentives to recruit younger workers who have less chances of landing in regular employment, unlike the older and more experienced ones. However, these co-ops would be in a better position to provide continuing employment as they can manage the placement schedules of its members from one job assignment to the next.
In the SBCC case, Quezon City did not have to allocate local funds as capital for micro-lending. In possible manpower service facilitation, local governments would not have to directly monitor the requirements of the employing firms. Link-up with manpower service co-ops can be most helpful in localities where people seek employment overseas of elsewhere in the country. Asiapro Cooperative, for example, supplies manpower services to firms based in Metro Manila and in Mindanao, and is studying to supply manpower services abroad.
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